As a general matter, mitigation of risk inherent in the investment by a manufacturer is relevant to consider only if the manufacturer assumes the risk. In practice, the investment by an associated enterprise in a manufacturing plant where that enterprise is wholly dependent on another associated enterprise for the capability to generate returns is likely to require careful scrutiny in relation to the identification of risks and how those risks are controlled. As explained in Example 2 in paragraphs 1.84 and 1.102 where significant risks associated with generating a return from the manufacturing activities are controlled solely by another party (which also has the financial capacity to bear that risk), then that other party is allocated the upside and downside consequences of those risks, including under-utilisation, write-down, and closure costs. In that case, the manufacturer should not suffer the financial consequences of an early termination, as it did not control the economically significant risks that contributed to the closure, and in such a case the manufacturer would also not be expected to mitigate risks it did not in fact assume ...

At arm’s length, the manufacturer may mitigate the risks inherent in the investment by: Including in the contract an appropriate indemnification clause or penalties in case of early termination, or an option for the party making the investment to transfer it at a given price to the other party in case the investment becomes useless to the former due to the early termination of the contract by the latter. Factoring the risk linked with the possible termination of the contract into the determination of the remuneration of the activities covered by the contract (e.g. by factoring the risk into the determination of the remuneration of the manufacturing activities where third party comparables that bear comparable risks can be identified, perhaps by including front-end loaded fee structures). In such a case the party making the investment consciously accepts the risk and is rewarded for it; no separate indemnification for the termination of the contract seems necessary ...

Another aspect that may be necessary to examine in assessing whether the conditions of an arrangement in relation to an indemnification clause are arm’s length, is the remuneration of the transactions that are the object of the arrangement and the financial conditions of the termination thereof, as both can be inter-related. In effect, the terms of a termination clause (or the absence thereof) may be a significant element of the functional analysis of the transactions and specifically of the analysis of the risks of the parties, and may accordingly need to be taken into account in the determination of an arm’s length remuneration for the transactions. Similarly, the remuneration of the transactions will affect the determination of whether the conditions of the termination of the arrangement are at arm’s length ...

However, in those cases where such comparables data are not found, the determination of whether the indemnification clause (or absence thereof) is arm’s length should take into account the rights and other assets of the parties at the time of entering into the arrangement and of its termination or renegotiation. This analysis might also be assisted by an examination of the options realistically available to the parties, as in some situations, it may be the case that, in comparable circumstances, an independent party would not have had any option realistically available that would be clearly more attractive to it than to accept the conditions of the termination or substantial renegotiation of the contract. The guidance in Section D of Chapter I, as well as the Guidance in Section B of this Part, are applicable ...

Once the existence or absence of an indemnification clause in favour of the restructured entity upon termination, non-renewal or substantial renegotiation of the agreements has been determined, the analysis should then focus on assessing whether such indemnification clause and its terms (or absence thereof) are arm’s length. Where comparables data evidence a similar indemnification clause (or absence thereof) in comparable circumstances, the indemnification clause (or absence thereof) in a controlled transaction will be regarded as arm’s length ...

The accurate delineation of the transaction will identify whether an indemnification clause or arrangement is in place upon termination, non-renewal or re-negotiation of the arrangements. In order to do so, the starting point should be a review of whether an indemnification clause or similar provision for termination, non-renewal or renegotiation is provided for, and of whether the conditions for termination, non-renewal or renegotiation of the contract were respected (e.g. with regard to any required notice period). However, the examination of the terms of the contract between the associated enterprises may not suffice from a transfer pricing perspective as the mere fact that a given terminated, non-renewed or renegotiated contract did not provide an indemnification or similar provision does not necessarily mean that this is arm’s length, as discussed below ...

Once the restructuring arrangements have been accurately delineated and the options realistically available to the parties have been assessed, the following aspects should be considered: Whether commercial law supports rights to indemnification for the restructured entity under the facts of the case as accurately delineated (see Section F. 1 below); Whether the existence or absence of an indemnification clause or similar provisions (as well as the terms of such a clause where it exists) under the terms of the arrangement, as accurately delineated, is arm’s length (see Section F.2 below). Which party should ultimately bear the costs related to the indemnification of the party that suffers from the termination or re-negotiation of the agreement (see Section F.3 below) ...

As a general matter, mitigation of risk inherent in the investment by a manufacturer is relevant to consider only if the manufacturer assumes the risk. In practice, the investment by an associated enterprise in a manufacturing plant where that enterprise is wholly dependent on another associated enterprise for the capability to generate returns is likely to require careful scrutiny in relation to the identification of risks and how those risks are controlled. As explained in Example 2 in paragraphs 1.84 and 1.102 where significant risks associated with generating a return from the manufacturing activities are controlled solely by another party (which also has the financial capacity to bear that risk), then that other party is allocated the upside and downside consequences of those risks, including under-utilisation, write-down, and closure costs. In that case, the manufacturer should not suffer the financial consequences of an early termination, as it did not control the economically significant risks that contributed to the closure, and in such a case the manufacturer would also not be expected to mitigate risks it did not in fact assume ...

At arm’s length, the manufacturer may mitigate the risks inherent in the investment by: Including in the contract an appropriate indemnification clause or penalties in case of early termination, or an option for the party making the investment to transfer it at a given price to the other party in case the investment becomes useless to the former due to the early termination of the contract by the latter. Factoring the risk linked with the possible termination of the contract into the determination of the remuneration of the activities covered by the contract (e.g. by factoring the risk into the determination of the remuneration of the manufacturing activities where third party comparables that bear comparable risks can be identified, perhaps by including front-end loaded fee structures). In such a case the party making the investment consciously accepts the risk and is rewarded for it; no separate indemnification for the termination of the contract seems necessary ...

Another aspect that may be necessary to examine in assessing whether the conditions of an arrangement in relation to an indemnification clause are arm’s length, is the remuneration of the transactions that are the object of the arrangement and the financial conditions of the termination thereof, as both can be inter-related. In effect, the terms of a termination clause (or the absence thereof) may be a significant element of the functional analysis of the transactions and specifically of the analysis of the risks of the parties, and may accordingly need to be taken into account in the determination of an arm’s length remuneration for the transactions. Similarly, the remuneration of the transactions will affect the determination of whether the conditions of the termination of the arrangement are at arm’s length ...

However, in those cases where such comparables data are not found, the determination of whether the indemnification clause (or absence thereof) is arm’s length should take into account the rights and other assets of the parties at the time of entering into the arrangement and of its termination or renegotiation. This analysis might also be assisted by an examination of the options realistically available to the parties, as in some situations, it may be the case that, in comparable circumstances, an independent party would not have had any option realistically available that would be clearly more attractive to it than to accept the conditions of the termination or substantial renegotiation of the contract. The guidance in Section D of Chapter I, as well as the Guidance in Section B of this Part, are applicable ...

Once the existence or absence of an indemnification clause in favour of the restructured entity upon termination, non-renewal or substantial renegotiation of the agreements has been determined, the analysis should then focus on assessing whether such indemnification clause and its terms (or absence thereof) are arm’s length. Where comparables data evidence a similar indemnification clause (or absence thereof) in comparable circumstances, the indemnification clause (or absence thereof) in a controlled transaction will be regarded as arm’s length ...

The accurate delineation of the transaction will identify whether an indemnification clause or arrangement is in place upon termination, non-renewal or re-negotiation of the arrangements. In order to do so, the starting point should be a review of whether an indemnification clause or similar provision for termination, non-renewal or renegotiation is provided for, and of whether the conditions for termination, non-renewal or renegotiation of the contract were respected (e.g. with regard to any required notice period). However, the examination of the terms of the contract between the associated enterprises may not suffice from a transfer pricing perspective as the mere fact that a given terminated, non-renewed or renegotiated contract did not provide an indemnification or similar provision does not necessarily mean that this is arm’s length, as discussed below ...

Once the restructuring arrangements have been accurately delineated and the options realistically available to the parties have been assessed, the following aspects should be considered: Whether commercial law supports rights to indemnification for the restructured entity under the facts of the case as accurately delineated (see Section F. 1 below); Whether the existence or absence of an indemnification clause or similar provisions (as well as the terms of such a clause where it exists) under the terms of the arrangement, as accurately delineated, is arm’s length (see Section F.2 below). Which party should ultimately bear the costs related to the indemnification of the party that suffers from the termination or re-negotiation of the agreement (see Section F.3 below) ...